A prime opportunity for profit or an over-priced shares trap? What you need to know about IPOs and the floatation frenzy

The stock market has gripped by floatation fever as companies rush to to list their shares and raise money as prices are riding high.

The listing of the Royal Mail last year
reignited the public's interest in shares and several well known
businesses, such as Pets at Home, Poundland, Just Eat and AO World have followed suit.

This week Luke Johnson, the man who put Pizza Express on the map, floated cafe chain Patisserie Valerie, while investors are currently mulling whether to buy into
Saga shares. Shares from Lloyds Bank offshoot TSB and property listing website Zoopla, are also tipped to hit the market this year.

But is investing into an IPO - as initial public offerings are known - or floatation a wise idea and how do they work? We take a look at the typical process and explain some things you need to consider.

Floats: Royal Mail floated last year, Saga will float at the end of May and TSB is considering a listing this year

A listing is commonly referred to as a floatation, or IPO and can raise money from either institutional investors. such as pension funds and fund managers, or what are known as retail investors, which are members of the public.

Companies list for various reasons. Some move from government hands, as the Royal Mail did, some want to fund expansion, and many of those which have listed this year are being put on the market by private equity owners looking to cash in on their stake in a business.

Poundland, Pets at Home and Saga had all been previously bought by private equity firms, who then decided that this year was the ideal time to make some money on their ownership.

Tumbling price: Just Eat floated at a sky-high valuation of 150 times earnings - its shares have suffered since

Investing in an IPO can get investors involved with a fast-growing company, or be a way into firms that promise to pay a stable dividend or income.

You need to consider the reasons for listing and the finances and business plan behind a company to see if it is worth putting money into an IPO.

Some shares will be good for growth while others will be good income payers and provide a steady dividend each year.

What's absolutely crucial to success is the price. The immediate gains seen on Royal Mail shares may have looked extremely tasty, but there are many IPOs don't end up being particularly good deals for initial investors.

Some investors believe in avoiding IPOs altogether, as they say that they have a far greater tendency to be hyped up and over-priced. They prefer to let the dust settle and the market decide the price after listing before buying in. Others will take part in IPOs, but do so only very cautiously.

If a listing price is too low there may be a chance of getting in cheap and making a good profit on the share, but if it is too high there may not be much room to grow and any disappointing news or failure to deliver on growth by the company could send your investment tumbling.

Blindly rushing into what you think is a good story share is a dangerous game.

Leading fund manager Mark Slater, who runs the five-year top performing UK All Companies fund MFM Slater Growth, has this advice for investors buying shares: 'You’ve got to get in at the right price. If you get in at an unreasonable price, the odds of it working out well are greatly diminished.’

How an IPO works

So if you are going to invest, how does an IPO work. We asked shares administration specialists Equiniti to outline the typical stages.

Weeks 1 and 2: Company announces intention to float

The announcement will contain a summary of the type of business and what it does as well as is past financial performance and the timing of the IPO.

It will also include details of how much of the company is on offer and how much it wants to raise. Often a listing is only offered to institutional investors, these are big companies such as pension funds, as they can attract bigger funds.

There may be different deadlines for various types of investors such as employees, those going direct and those using brokers.

Early in week 4: Time to decide if you want to invest

This is the time to decide if you want to apply for shares and to make sure you have enough money in your dealing account to do so.

The deadline may be different if you are applying through a broker rather than direct.

Study the prospectus for details of a firms’ finances, does it generate revenue and profits.

Think about the sector it is in, what problems could it face and how it compares to its peers.

Look at the valuation and consider whether it is worth it, could you buy a share in a similar company for less? Is it worth paying the upper range for the share and do you think it has further to grow?You must then decide how much you want to invest.

Most listings have a minimum such as £1,000, but this can be reduced if there is a lot of interest. For example during last year’s Royal Mail IPO, everyone who asked for less than £10,000 of shares got £749.50 due to the amount of interest.

Anyone with more than £10,000 got nothing.

IPO: The first two weeks are all about the float announcement, followed by speculation, the offer price and finally a listing

Week 5: The listing price is decided and conditional dealing begins

In this week the company will announce the offer price which is the value that the shares will list at.

The announcement will also say how much has been raised and whether investors have had their allocations scaled back.

If demand has been high a company may decide to increase the price above the range. If this happens then an investor has 48 hours to withdraw if they wish.

There will then be a period of ‘conditional dealing.’ This takes place about a week before a company officially lists and is similar to the period between the exchange and completion process when buying a house.

The conditional dealing period is an opportunity to make user the mechanisms behind the float are working.

Some investors will be allowed to sell shares, usually institutional or direct shareholders, but they will only complete once the listing takes place and 'unconditional dealing' begins.

The risk is that you offload your shares and then miss out if the price increases when it officially lists.

Week 6: The company enters the stock market

The company will officially enter the stock market and unconditional or the official dealing begins.

Those who applied online will receive their allocation and any share certificates requested will be sent out in the post.

The first day is important as there can often be a big rise in price as the stock gets really popular.

This was seen with the Royal Mail which shot up quickly from 330p and is now worth more than 550p.

You have to decide if you should use this opportunity to sell and take advantage of this rally or hold on if you are going for more of an income stock.

Once you hold the share, keep an eye on the price and any company results or dividend announcements to keep track of any returns and decide if and when you should sell out or buy more stock.

WHAT YOU NEED TO KNOW WHEN INVESTING IN AN IPO

Discipline

Retail investors frequently struggle to commit to making a trade. Engaging in an IPO gives the discipline to get involved in the market and assuming that this is being seen as a long-term investment, mistiming the purchase shouldn't be a major concern.

Opportunity cost

Investing in an IPO involves committing money to the application on the assumption that you will be awarded the shares you apply for. In the current era of low interest rates there's little cost incurred if you're using cash for offers like this.

However, taking money out of other equity holdings to participate in an IPO comes with the risk that your application is unsuccessful, leaving you with uninvested cash for a period of several weeks.

It's rarely free money

At an IPO, the listing company wants to achieve the very best price it can and in the majority of instances this does happen.

However, privatisation of state assets tend to be high profile and can also buck this trend, as government wouldn't want the political embarrassment of a sale being unsuccessful. The quick profits made in the Royal Mail IPO shouldn't be taken as the natural course of events for any listing.

It might be a flop

The shares issued in an IPO are underwritten - for what is essentially an insurance premium - by a group of banks. That is, if they can't be sold in the market then this panel of institutions will pick up the slack. They may then decide to sell the stock quickly, driving the price immediately lower and leaving investors out of pocket.

Stamp Duty

Unlike
other share transactions, IPOs are exempt from stamp duty, so buying at
this stage means you save an effective 0.5 per cent as opposed to
buying after public trading has commenced.

Dealing fees

There
are no dealing fees when you apply direct and typically a stockbroker
won't charge you if you apply for an IPO through them, either. Depending
on how much your broker charges you to trade, the savings here will
fluctuate.

Note that
the broker receives a commission of typically 0.75 per cent from the
issuer for shares it successfully places with investors.

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FUND JARGON BUSTER

The investment industry's world of abbreviations...Acc: Accumulation - any income generated by the fund like dividends or interest is automatically reinvested.Inc: Income - any income generated is distributed by the fund instead of being reinvested. Dis: Distribution - any income generated is distributed by the fund instead of being reinvested. R: Retail - the fund is aimed at ordinary investors. I/Inst: Institutional - the fund is aimed at corporate investors like pension funds. A, B, M, X etc: Different fund houses use letters for different things. Check with them what they stand for. NT/No trail: Some fund houses use this name on clean funds which carry no commissions for financial advisers, supermarkets or brokers, just the fee levied by the fund manager. But other fund houses use different letters - I, D or Y, for example - so you need to find out for yourself which are clean funds. Gr: Stands for gross. GBP/£: Fund denominated in pounds. EUR: Fund denominated in euros. USD/$: Fund denominated in US dollars. Compiled with online stockbroker The Share Centre